1.1 Technical Field
The invention relates to methods and financial systems for analyzing and predicting market winners and market losers. More particularly, the present invention allows portfolio managers to select winners and losers by using a volume/turnover filter together with price momentum and make better informed decisions regarding whether and what to trade, thereby adding value to the trading process. Traders should find the present invention useful in helping them decide what issues should be held long verses short to maximize profits.
1.2 Conventional Art
“Buy low, sell high” has been the mantra of financial traders. In general, traders attempt to buy stocks at a low price then sell at a higher price. However, predicting the best time to buy or sell a stock is difficult. It has been recognized that stocks at times follow a momentum life cycle as shown in FIG. 2 (as documented by Charles M. C. Lee and Bhaskaran Swaminathan, “Price Momentum and Trading Volume”, Working Paper, Johnson Graduate School of Management—Cornell University, Jun. 23, 1998). The approach shown in FIG. 2 shows how trading of stock over time will shift from high-volume to low-volume and back again against winning and losing (increasing or decreasing stock price).
The momentum life cycle (MLC) hypothesis for price momentum, reversal and trading volume suggests that stocks and portfolios go through periods of investor favoritism and neglect. A stock or portfolio with positive price momentum (prior winners) would be on the left half of the MLC, while a stock or portfolio with a negative price momentum (prior losers) would be on the right half of the MLC.
Growth stocks with positive momentum move up the MLC but eventually become “torpedoes.” Stocks that have negative momentum begin a downward slide and then may experience neglect. The price may continue to fall until investors become interested again.
Trading volume and turnover provide information useful in determining where the stock is in its MLC. When a stock becomes popular, trading volume increases. Conversely, when a stock becomes unpopular, trading volume declines. Accordingly, trading volume is a measure of the favoritism or neglect of a stock. The MLC shows that high-volume winners and low-volume losers are late-stage momentum stocks that may be close to a reversal. Alternatively, low-volume winners and high-volume losers are early-stage momentum stocks whose momentum is likely to continue in a winning direction and losing direction, respectively.
However, this conventional approach does not readily predict where a given stock is on the momentum life cycle, nor does it provide ready selection of a portfolio of stocks during which an investor may exploit the momentum life cycle.